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How War and Peace Impact Market Returns

Last week, I wrote that when you invest utilizing index funds that replicate the overall market your investment success is dependent on certain things remaining in place. Namely, the continued existence of capitalism and long-term economic growth.

Even active managers that are seeking to outperform the market are highly dependent on the continued existence of capitalism and long-term economic growth.

In addition, these active managers’ success is also dependent on their ability to accurately predict what will change for specific industries, companies and market segments.

To Be Active

Active investment managers seek some type of informational edge relative to the market regarding the prospects for specific securities.

These managers believe either the market has mispriced the security and the price will eventually be corrected, or they believe they have insight into the company or market segment’s future that has yet to be recognized by other market participants.

For many years, I traveled the globe trying to find those rare firms with investment skill. I co-led a 20 person research team with the same objective.

Skilled investment managers are difficult to identify for the simple reason that even highly skilled firms go through periods of underperformance. Conversely, unskilled managers can get lucky for a time.

In addition, investment firms are always changing.

Team or Star?

Recently, PIMCO, one of the largest bond managers in the world, announced that Bill Gross, the firm’s co-founder and Chief Investment Officer had left the firm to join Janus, a competing investment firm.

Existing clients of PIMCO must now decide how instrumental Bill Gross was in delivering long-term outperformance for the firm’s flagship bond funds and other investment strategies.

Was it a team effort where Gross played a supporting role so even with his departure the team will continue to be successful if not more so? Or was Gross the glue that held the team together, and he was primarily responsible for the firm’s success.

Only time will tell.

Conflict and Confiscation

Returning to the earlier issue, have there been times when capitalism and economic growth were so severely disrupted that even a passive indexing strategy would have been unsuccessful?

Yes, but they are extremely rare. These major market disruptions usually involve war or a political regime change where assets are confiscated.

The U.S. stock market fortunately has overcome wars and other conflicts to deliver very strong long-term performance.